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This Is the Worst Case Scenario for Facebook Shareholders

Snapchat CEO Evan Spiegel lays out the bear case for Facebook.

Among large cap tech stocks, few have performed as well as Facebook(NASDAQ:FB) in recent years -- shares have nearly tripled since Aug. 2012. The social network has monetized its mobile app and continued to add users, debunking nearly every bearish argument along the way.

But there is a case to be made against Facebook. And who better to make it than the leader of one of its upstart rivals?

In Nov. 2013, Evan Spiegel, the CEO of Snapchat, sent out an email offering up what may be the ultimate bear case. Reading it today, the message rings truer than ever before as Facebook increasingly relies on its mobile business.

Facebook could be particularly susceptible to a tech bubble burstAccording to Spiegel, Facebook is dangerously reliant on start-up, app-based companies. When these companies -- which are mostly venture-backed -- inevitability run into problems, Facebook mobile advertising revenue will collapse, and its stock price will plummet.

In an email to Michael Lynton, a Snapchat board member, Spiegel writes the following (via Business Insider):

Facebook has continued to perform in the market ... largely due to mobile advertising performance -- especially App Install advertisements. This is a huge red flag because it indicates that sustainable brand dollars have not yet moved to Facebook mobile platform and mobile revenue growth has been driven by technology companies (many of which are [venture] funded). [Venture capital] dollars are being spent on user acquisition ... This props up Facebook share price and continues to justify [further venture] investment in technology ... based on [Facebook's valuation] ... When the market for tech stocks cools, [Facebook's] market cap will plummet, access to capital for unproven businesses will become inaccessible, and ad spend on user acquisition will rapidly decrease-compounding problems for Facebook and driving [its] stock even lower."

This is not an unfounded argument. Almost all of Facebook's 300% gains have come on the back of its strong performance in mobile. Shortly after its IPO, Facebook shares plunged as investors wondered if it would be able to successfully adopt its business model -- which had, until that point, depended on desktop ads -- to increasingly popular mobile devices.

Today, mobile advertisements make up the overwhelming majority of the business. Last quarter, 69% of advertising revenue came from mobile, up from 53% in the prior year.

Many of these ads are for apps. Open Facebook mobile, and there is a good chance you will see at least one ad prompting you to install a new app (as I write this, Facebook is suggesting I install Game of War: Fire Age, Knights & Dragons, and Mango Health, among others).

It is difficult to say how many of these ads are from venture-backed companies (two of the three in the above example), or how dependent Facebook is upon them. Unfortunately, the company simply does not offer much in the way of an advertising breakdown.

Management insists its mobile app revenue is "broad-based"Facebook management, however, has been willing to address the topic in recent earnings calls. In October, COO Sheryl Sandberg said that the growth in mobile ads was "very broad based."

Sandberg specifically cited Burger King as an example of a company that was using its app install ads to great success (suggesting that it is not just high-flying, speculative, venture-backed companies buying app install ads but relatively stable firms operating in established industries).

Moreover, there is nothing wrong, per se, with the idea of an app install ad. Apps are popular, and current app stores do a fairly lousy job at curating their often mammoth offerings. Companies need a way to popularize their apps, and Facebook is providing it.

The crux of Spiegel's argument rests on the notion that we are currently enjoying a tech bubble -- or at least some sort of speculative mania in the sector. Hedge fund manager David Einhorn made a similar argument last year,while other famed investors, including Peter Thiel, dispute it.

Further disclosure would be niceThe social network could dispel some of these concerns if it offered a better breakdown of where its mobile ad revenues are coming from. Of course, if it is a significant percentage, it would only make matters worse.

Ultimately, those that believe we are, in fact, witnessing a second tech bubble or are skeptical of the app-based economy, probably are not Facebook shareholders to begin with. Still, it is interesting to note Facebook's heavy reliance on other tech firms for much of its recent success -- if tech stocks are ripe for a correction, Facebook could be particularly vulnerable.